Got A Life Insurance Policy Here?

Better tell your uncle about it
BY: ORLANDO GOTAY

It seems perfectly logical that while living abroad, one may purchase life, health or accident insurance.  Normally, these should bring peace of mind. Right?

But what about the liabilityof that?  Huh? Regrettably, that’s what some foreign insurance policies could bring, if one is not careful.

There are a host of rules that apply when a U.S. person buys foreign life insurance.  Did you know there’s a special federal excise tax on premiums?  If a policy has a cash surrender value, it may also be annually reportable in a Foreign Bank Account Report and further, possibly as a ‘specified foreign financial asset’ in one’s tax return.  Making it even more exciting, any gains in value in the policy itself could be reportable and subject to tax.

You may now begin to understand the general rule, (at least in my ever so prudent mind), that whenever a U.S. citizen gets involved in a foreign financial transaction of any kind, anything, it is best to pull out the microscope and look at it very, very carefully, from the U.S. tax perspective.

The IRS imposes a tax of one percent of the premium paid for life, health, or accident insurance issued by foreign insurers that benefit a U.S. citizen.  There are some exceptions, and the U.S. Mexico tax treaty provides for some, but they don’t benefit you, Mr. or Ms. U.S. citizen.  They only seem to benefit Mexican insurance companies.  You could be on the hook for the excise tax.

Remember that cash value life policies are in fact an investment, right? (That’s why they have a cash value). The Internal Revenue Code has a very strict definition of what a life insurance contract is, and it may be that foreign life policies may not fit exactly within that American definition.  In that case, you may have to include as ordinary income the increase in value of your policy.

Foreign policies that have a cash value can also be considered “specified foreign financial assets”.  Owning above a certain dollar amount of those assets may trigger a reporting requirement on Form 8938.  To make this even more exciting, those very cash value life insurance policies may also be “foreign financial accounts” for Foreign Bank Account Report (FBAR) purposes, trigering the need for another report and a new opportunity for the IRS to stick you with a penalty if not timely filed.

Orlando Gotay is a California licensed tax attorney (with a Master of Laws in Taxation) admitted to practice before the IRS, the U.S. Tax Court and other taxing agencies.  His love of things Mexican has led him to devote part of his practice to the tax matters of U.S. expats in Mexico.  He can be reached at tax@orlandogotay.com